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Can Fraud be adjudicated through Arbitration or a Court of Law?

The duty of an arbitrator is very clearly ear marked and defined under the law as per the terms of the arbitration agreement executed between the parties in question.

The duty of an arbitrator is very clearly ear marked and defined under the law as per the terms of the arbitration agreement executed between the parties in question. Basically an arbitrator’s powers and his jurisdiction extend only up till the extent defined under the clause for arbitration. However, there exist certain disputes which cannot be permitted to operate under the facility of arbitration proceedings, regardless of if the same are covered under the arbitration clause or not. For example, any dispute which arises out of a “right in rem” which basically refers to a right which is enforceable against the world at large, cannot come under the purview of arbitration.

Even though when we speak of fraud, it is referred to as a Right in Personam, the extent to which arbitration can be applied to the same is still a largely controversial topic under Indian law.  
Arbitrability of fraud
  • The Arbitration and Conciliation Act, 1996, has failed to make any provisions pertaining to the exclusion of certain categories of disputes as non-arbitrable. It was in fact the Supreme Court which opined and decided over this factor under the Booz-Allen Hamilton case. This landmark judgment by the Supreme Court laid down certain aspects which once and for all cleared all ambiguities pertaining to what can and what cannot be referred to arbitration under the law. In Booz Allen, the Supreme Court settled that matters pertaining to testamentary issues, tenancy, guardianship, winding up, insolvency, matrimony and crimes, are non-arbitrable. Furthermore, in the case of Vimal Kishore Shah v. Jayesh Dinesh Shah, the Supreme Court added another category which was all disputes relating to trusts, trustees and beneficiaries as a category over which arbitration cannot be resorted to.
  • However, the legal position with respect to the arbitrability of fraud had only been settled by the Supreme Court in the case of A. Ayyasamy v. P. Paramasivam (Ayyasamy). Under this case, the appellant and the respondent were both brothers who had entered into a partnership deed for establishing a hotel business in Tamil Nadu. The partnership deed comprised of an arbitration clause for any disputes arising from the same. Subsequently, after facing certain allegations of fraud due to mishandling of accounts, the respondent sought an injunction from a civil court for preventing the appellant from managing the hotel. Instead, the appellant filed an application under Section 8 of the Arbitration and Conciliation Act and referred the dispute to arbitration as had been put in the agreement.
  • Relying on N. Radhakrishnan v. Maestro Engineers, the trial court dismissed this application and observed that such allegations of fraud could not be adjudicated by an arbitral tribunal and that it was the civil court which had the appropriate authority to adjudicate over the same. Later, in an appeal, the Madras High Court confirmed the trial court’s findings and further stated that the decision rendered in N. Radhakrishnan completely trumped the decision given under Swiss Timing v. Organizing Committee, Commonwealth Games 2010 on account of hierarchy in bench.
  • However, it was the Supreme Court which decided that all simple allegations which touched upon any internal affairs of either parties would not be a sufficient point for detracting from the obligation of either parties to submit the dispute to arbitration. However, it was also observed that certain specific disputes shall still not be arbitrable if they are of a serious and complex nature of fraud wherein only a civil court of appropriate authority can adjudicate over. Furthermore, it was also stated that no dispute is amenable to arbitration wherein fraud has been alleged against the arbitration provision in itself or is of such a nature which permeates the entire contract, including the agreement to arbitrate as well.
  • All other uncertainties pertaining to the uncertainty with regards to whether fraud can come under the purview of arbitration in case of any dispute between parties had been concluded by the decision held in the case of Rashid Raza v. Sadaf Akhtarby a 3-judge bench of the Supreme Court. Herein, the dispute was regarding a partnership deed wherein it had been alleged that one of the partners was responsible for siphoning off funds and was also involved in committing other improprieties with regards to the business as well.
  • Here, the Supreme Court, clearly demarcated that the allegations pertaining to fraud shall only be of a serious nature, and thus non arbitrable if a criminal offence could be found in the ordinary course of action there. Moreover, the apex court also stated that the nature of the dispute should also be so complex so as to involve the civil court as an adjudicating authority as the more appropriate forum for the deliverance of justice, which was not the case under the resent dispute.
Avitel Post Studioz Limited v HSBC PI Holdings (Mauritius)
The point in question now is the latest landmark judgment provided by the Supreme Court in the case of Avitel Post Studioz Limited v. HSBC PI Holdings (Mauritius) which has again resorted to the question of whether allegations of fraud can be adjudicated  in arbitration or not. The apex court in its judgment, laid down certain clear tests for determining if any dispute involving fraud can be arbitrated over or if it requires due interference from a civil court of appropriate jurisdiction.

Facts of the Case
  • Under the present case a Share Subscription Agreement (“SSA”) had been entered into on April 21, 2011, between Avitel and HSBC, through which HSBC invested USD 60 million in Avitel for acquiring 7.80% of the total number of shares.
  • This SSA comprised of a clause stating arbitration as the ideal mechanism for dispute resolution at the Singapore International Arbitration Centre in case of a dispute. Moreover, another additional Shareholders’ Agreement (“SHA”) had also been entered into on May 6, 2011, which also comprised of a similar clause for arbitration.
  • A dispute then arose between both the parties with HSBC alleging that the promoters of Avitel. Which is the Jain family induced HSBC to invest in Avitel by making a false representation claiming that Avitel was about to enter into a very promising contract with the British Broadcasting Corporation. HSBC alleged that there existed no such contract or even a promise of one and that nearly USD 51 million from the USD 60 million investment had been siphoned off by Avitel to other companies which were owned and controlled by the Jain Family.
  • Consequently, Arbitral proceedings had been resorted to and a final award had been given in favour of HSBC holding the above allegations to be true. However, the matter then reached the Supreme Court in the context of a petition under Section 9 of the Arbitration and Conciliation Act, 1996, filed by HSBC which sought further orders of deposit of a full claim for the amount of USD 60 million in order to protect the subject matter of the Award.
The Supreme Court’s verdict
  • Once the Court had presided over the matter and taken stock with respect to the jurisprudence over the issue of fraud, the Court held that “serious allegations of fraud”, leading to non-arbitrability would only arise if either of following two tests were satisfied, and not otherwise. These are:
  1. In case the Court finds that the arbitration agreement itself cannot be said to be in existence due to being vitiated by fraud.
  2. In case the allegations made are against the State or its instrumentalities, relating to arbitrary, fraudulent, or mala fide conduct, which would result in discrepancies in public law instead of any questions limited to the contractual relationship between the parties herein.
  • After applying the two tests provided above, the Court was of the opinion that the issues raised and answered in the Award were the subject matter of civil suit and not any criminal proceedings. Further the fact that a separate criminal proceeding was sought to be initiated by HSBC is of no consequence whatsoever and it was therefore held that the impersonation, false representations and siphoning off of the funds, were all inter parties and had no “public flavour” so as to be non-arbitrable on account of allegations of fraud.
  • As such, the Supreme Court inter alia upheld the orders for the deposit of the entire claim amount of USD 60 million to be kept aside for the purposes of enforcement of the Award in India. 

The judgment of the Supreme Court’s in the Avitel Case provides much needed clarity over the matter of what kind of a case of fraud can come within the ambit of arbitration and what kind must be resolved by a Court of appropriate jurisdiction. The two tests laid down formed the arbitrability of matters involving serious allegations of fraud making them easily distinguishable as well. 

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